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Are ADR's or Mutual Funds Better for Global Diversification?
Category: Finance
Article added by: Cathy Pareto


The benefits of international investing cannot be denied. There have been countless articles
and papers written on the subject already that are beyond the scope of this article. But what
exactly is the best method of gaining international exposure in your portfolio? Should you
consider exposure to foreign companies via American Depository Receipts or are mutual funds a more optimal solution?

American depository receipts (or ADR’s) are securities created by a U.S. bank that represent
shares in foreign companies that are held at the bank. An ADR may represent a portion of a
foreign share, one share or a bundle of shares. ADR’s themselves are not stocks, but
certificates held by U.S. banks. Like U.S. common stock, ADR’s trade on U.S. stock exchanges and pay dividends (subject to U.S. taxation).

ADR’s, like most foreign mutual funds, are denominated in dollars, but they do not eliminate the potential currency risk associated with investing in foreign markets. So, when the dollar is weak, investment returns in foreign positions are usually more robust. Inversely, when the dollar rallies against foreign currencies, ADR’s from those countries will fall more than if shares were held by direct investors in the company.

Unfortunately, if your objective is to achieve global diversification in your portfolio, ADR’s are
quite limiting. When you buy an ADR, you are gaining representation in one foreign company, a concentrated risk by most prudent standards. Furthermore, most ADR’s are limited to mid to large capitalization companies. So, even if an investor owned every traded ADR on the exchange, he/she would end up owning something similar to an EAFE index, but at a much higher acquisition cost.

We can all agree that the purpose of including foreign stocks in a portfolio is to control risk and maximize return. However, these dual objectives cannot be obtained solely with international large cap exposure (which is all that the ADR would provide). In order to accomplish your goal you should also include foreign value, foreign small, foreign small value and emerging markets. These simply cannot be attained with ADR’s.

So, for access to foreign markets, international mutual funds are a better alternative. They
have the ability to provide broad global representation while spreading risk across hundreds of companies, sectors, and countries around the world. The aforementioned asset classes like foreign small, foreign small value et al are all available to investors.

It should be noted that because international stocks are more costly to trade, foreign funds
typically carry higher expense ratios than their domestic counterparts. Furthermore, the
dividends of international stocks are subject to foreign taxation—even when the recipients are tax-exempt in the US (like a pension plan). Taxable investors, however, can receive credits for foreign taxes paid. Of course, cost conscious investors should consider global index funds or exchange traded funds to keep costs to a minimum.

Yet despite the potential cost and foreign tax implications, international mutual funds (unlike
ADR’s) allow investors to capture a broad array foreign exposure. When soundly combined with other domestic asset classes, international exposure is an essential building block in any
optimal portfolio, and mutual funds (not ADR’s) provide you with the best tools to achieve that goal.


Posted By: Cathy Pareto
Web: http://www.cathypareto.com
Contact: e-mail


About the Author:
Cathy Pareto, MBA, CFP®, AIF® is the Founder and President of Cathy Pareto & Associates, Inc. For over twelve years, Cathy has been helping financial consumers and professionals understand the world of investments and finance with a sound, but down to earth money management approach. Money management does not have to be an intimidating and mystifying process. Cathy's belief is that there is more to investment management and financial planning than just the numbers. It takes commitment, clear communication and trust between the Advisor and the Client to plan out a strategy, and it requires the experience of a competent Advisor to execute that strategy. For over a decade Cathy was a Senior Financial Advisor for another Miami based investment advisory firm, where she managed over $200 million in assets for high net worth clients and retirement plans. She has extensive experience in retirement issues, asset allocation, investment selection, investment management, education planning, estate planning coordination, and asset protection strategies. Additionally, she was an Adjunct Professor and Faculty Coordinator for the CFP® Program at Florida International University’s College of Business. Educational Background Cathy earned her BA in Finance and later her Executive MBA at Florida International University, graduating in the top 20% of her class and as a result she was inducted into the prestigious Beta Gamma Sigma Graduate Business Honors Society. In the Media Cathy Pareto’s articles have been published in periodicals and websites, including Women in Business,Investopedia.com, Miami Medicine, Florida Medical Business, AccountantsWorld.com, My Financial Advisor, Indexfunds.com, and Fundsinteracctive.com. Her media contributions include quotes in BusinessWeek, The Wall Street Journal, The Sun Sentinel, CNNfn, Latina Magazine, Hispanic Trends, AARP's Segunda Edad, and many other financial publications. She has appeared on television and radio shows including CNBC’s “Power Lunch”, WLRN/NPR’s “Topical Currents", “Wealth & Wisdom”, Total Picture Radio, Landed Radio and more. www.cathpareto.com Professional Memberships Greater Miami Estate Planning Council - Current Member of the Board of Directors United Way of Miami Dade Young Leaders - Current Member NAPFA National Association of Personal Financial Advisors - Current South East Region Board Member Florida International University Executive MBA - Current Member of Professional Advisory Board Financial Planning Association - Current Member